Stablecoins are full of promise and offer answers to many of the shortcomings of dominant but volatile virtual currencies, writes Ryosuke Oue of Atsumi & Sakai
Many circulating virtual currencies, such as Bitcoin, are highly volatile and the opportunities for their use are limited. A proposed solution to these shortcomings is the stablecoin: a virtual currency with a stable value such as Libra, the new virtual currency developed primarily by Facebook.
Stablecoins are likely to become widespread and are expected to have at least three broad applications.
At the top of the list, highly volatile currencies are inconvenient for fund transfers, as they are affected by the fluctuating market value of each payment and require a frequent recalculation of the applicable taxes. Stablecoins do not suffer from these faults so are more convenient for many transactions. They may therefore become a key tool for making daily payments and transferring money between individuals.
Second, using a fiat currency to purchase a cryptoasset online does not provide the security advantages offered by blockchain technology, which is available if the purchase is made using a cryptocurrency. Conversely, the use of high-volatility cryptocurrencies to buy cryptoassets runs the risk that the values of those cryptocurrencies fluctuate. Stablecoins can provide the security benefits of a blockchain without the risk of value fluctuations, meaning it could become prevalent in cryptoasset acquisitions.
And third, there is strong demand for dividends on security tokens to be paid in a virtual currency with a stable value in order to benefit from the security of blockchain, rather than by a fiat currency through bank accounts. Because of their properties, stablecoins could therefore become key to dividend payments for investment-type ICOs.
Stablecoins come in various guises but can be categorised by looking at the mechanism (if any) used to stabilise their value. At present, the major categories bundle together stablecoins that are secured by:
- Fiat currency – for example, Tether is a stablecoin backed by the US dollar and Coin (previously known as MUFG Coin) is a stablecoin backed by the Japanese yen;
- A commodity, such as precious metals;
- A cryptocurrency;
- A basket of assets; or
A stablecoin backed by a cryptocurrency is not effectively stable as the underlying cryptocurrency is unstable, and although unsecured stablecoins are said to be stabilised by controlling their supply, their true stability is questionable.
Libra, which is backed by several assets including some fiat currencies and securities, would be categorised as (d) above.
Japan's Ministry of Finance and Financial Services Agency (FSA) and the Bank of Japan have been engaging in extensive discussions on various issues relating to stablecoins such as Libra. They have recognised that if certain specific issues can be resolved, their use would be of great significance for international funds transfers.
In Japan, the legal nature of stablecoins is now under discussion. According to a general view, stablecoins will be categorised under the Payment Services Act (the Act) as either an 'exchange transaction', 'prepaid payment instrument' or 'cryptocurrency'.
Stablecoins can provide the security benefits of a blockchain without the risk of value fluctuations
Assuming that the various categories of stablecoin described above will be transferred from person to person or peer-to-peer, categorising stablecoins as an exchange transaction would cause difficulty when using them as a method for transferring value. This is because, under Japanese law, an exchange transaction can only be made through a third-party intermediary, such as a bank or a fund transfer service provider.
Stablecoins could be categorised as a prepaid payment instrument. However, refunds of such instruments are prohibited, which will clash with a stablecoin's refundable nature.
In regards to these points, the FSA has reportedly taken the position that: "In principle, stablecoin pegged to a legal currency does not fall into the category of 'cryptocurrency' based on [the Act]". This might be because currency-denominated assets do not fall under the cryptocurrency category as regulated under the Act. If this is the case, a stablecoin other than a stablecoin secured by fiat currency could be categorised as a cryptocurrency and would therefore be dealt at a cryptocurrency exchange regulated under the Act.
In contrast, a stablecoin that is secured by fiat currency would be categorised and regulated as a fund Transfer or prepaid payment instrument under the Act. Though it is still under discussion, some practitioners opine that Libra will be categorised as a cryptocurrency, since Libra is not only backed by one currency but also is backed by public bonds and other currencies.
In any case, the legal nature of each type of stablecoin can be expected to be clarified by regulatory guidelines, while taking into account the need for innovation and user protections.
|About the author|
Ryosuke Oue is a partner in Atsumi & Sakai and a core member of the firm's fintech team. Ryosuke acts for fintech companies as well as a major credit card issuing company. He has extensive experience in banking and finance, asset finance and structured finance, acting for a wide range of Japanese and international banks and financial institutions. He also has extensive experience advising foreign investors on renewable energy projects in Japan.